All of a sudden, economists are warning about a threat of inflation. It’s quite a turnaround. Not long ago everyone was wringing their hands over just the opposite, deflation, when prices fall.
Too much of either is bad. When prices and incomes fall in a period of deflation, economic growth can turn into shrinkage and people and businesses find they cannot pay their debts.
Inflation means every dollar buys less, making houses, cars and all other goods and services harder to afford. It can be devastating to retirees who have emphasized safety over growth by favoring fixed-income assets like bank savings and bonds over stocks.
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Many economists worry that the federal government’s policy of pumping money into circulation to stimulate the economy could trigger inflation. While the process can be reversed, it can’t turn on a dime.
Even a modest uptick in inflation can seriously undermine your strategy for retirement, college savings and other long-term goals.
Look at the BankingMyWay.com Savings, Taxes, and Inflation Calculator. If you started with no savings, put aside $500 a month for 30 years at an 8 percent return, you could have $708,807 after 30 years.
Assuming you did this in an IRA or 401(k) and paid no taxes along the way, that nest egg would buy what $283,640 buys today, thanks to the corrosive value of inflation at the long-term average of 3.1 percent.
Increase inflation to 5 percent and the savings would be worth only 164,002.
As a rule of thumb, you can withdraw only 4 percent of your retirement savings each year. With inflation at 3.1 percent, your retirement savings would produce enough annual income to buy what $11,345 buys today. At 5 percent inflation, your income would be just $6,560.
That’s not much to show for 30 years of saving.
Since there’s nothing you can do to control inflation, there are four ways to attack the problem: save more every month, reach for a bigger investment return, plan to retire later, expect to spend less after retirement. Use the Retirement Planner to see how changing these factors can affect the outcome.
